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An Explanation of Put/Call Ratios

It’s pretty exciting when you make the decision that you’re ready to start investing in the stock market. It can be a viable investment strategy to earn more money for both new and veteran investors. Especially when you’re relatively new to investing, you may want to learn more about market indicators, which can give you a clue as to how the market, a fund, or an individual security is trending and help guide your investment decisions.

One of the greatest ways to measure how an overall market or specific security is doing is by looking at its associated put/call ratio. The ratio remains a reliable indicator of how the market is trending, and many investors use it to figure out what their best option is for buying and selling stocks. Learn more about the put/call ratio, including what it indicates, different ways to interpret it, and details on buying puts and calls.

What Is a Put/Call Ratio?

Image via Flickr by Got Credit

A put/call ratio is a security’s volume of put options relative to its call options, usually over a period of time like a day or a week. It is used by investors to measure how well (or not so well) the stock market is doing. It’s made up of two parts, and you can probably guess what they are:

  • A put, also called a “put option,” is a stock owner’s right to sell their securities at a certain predetermined price. Traders who hold a put are expecting that the price of the security will decrease in cost because they make money when the price falls below the target (strike) price before the expiration date. More puts than calls in the market indicate that the market is bearish, meaning the prices of stocks will probably be in a decline, sometimes even more than 20%.
  • The call, also called a “call option,” is the opposite. It’s the right for a buyer to purchase assets at a predetermined price. Traders who hold a call option are expecting that the price of the security will increase in cost. When traders are buying more calls than puts, it indicates that the market is bullish and therefore, stock values are rising overall.

When there are more put options than call options, the ratio is above one. When there are more call options than put options, the ratio is below one.

The calculation of the put/call ratio is: Put/Call Ratio = Put Volume / Call Volume

What Does a Put/Call Ratio Indicate?

Think about how each security can increase or decrease in value all on its own. There are so many companies represented in the stock market that you can’t always expect every single one’s value to go up or down at the same time and by the same percentage. So, each security can have its own put/call ratio that can determine how it is performing.

However, even with this being the case, in any economic upswing or downswing you may notice a trend of most stocks’ put/call ratio moving in the same direction. Some technical traders and stock market analysts use an overall put/call ratio to get a better sense of how the sentiment of the market is doing as a whole, with many of them looking toward the popular S&P 500 to begin with.

Understanding the Put/Call Ratio

To the person new to investing, you may want to make it as simple as possible for yourself. It’s usually best practice to sell when the p/c ratio is higher and buy when the p/c ratio is lower. The reason for this is when the ratio is higher, it indicates that most investors are expecting a future decline and therefore, protecting against that decline in the price of the stock.

Keep in mind that not all put/call ratios have to be high or low — they can also stay close to its current value. A ratio between 0.70 and 1.0 generally indicates a more horizontal trend in the stock, without much movement up or down to indicate either a bearish or bullish market.

To go just a little further, let’s examine how some more experienced traders interpret the put/call ratio. These traders know that, beyond the indication of how the market is doing, the put/call ratio is also used as a bet, or insurance, that a stock will go one way or the other.

Contrarian traders will figure that most investors are placing some insurance on one side over the other (sell-side versus buy-side) because of a general consensus of how prices are moving. For example, if most investors are placing insurance on the sell-side, it typically means they’re concerned that the price will start dropping. On the other hand, more insurance placed on the buy-side means that the major expectation is that the price will start rising.

When contrarian traders see this happen, they’ll do the opposite by buying when the ratio is above one and selling when the ratio is below one. Their goal is to make money on an eventual correction.

As you can see, how you interpret the put/call ratio can be different from another investor’s approach. Everyone’s investment philosophy is unique, investors’ actions vary, and there isn’t a right or wrong way to view the ratio. What’s most important is to understand the put/call ratio enough to make an informed decision for your investment.

Buying a Put Option

Buying a put option isn’t complicated, and it can often be cheaper and give you more leverage than other trading options. Follow these steps to purchase a put option:

  1. Find a stock to buy. The goal is to invest in a security that you expect will decrease in value over a certain period of time. You can identify this asset by getting feedback from an experienced broker or investor, looking at the security’s trend, or paying attention to its put/call ratio.
  2. Select an expiration date. The expiration date is the amount of time you’re allowing yourself to decide on your purchase. It’s a good idea to give yourself a bit of extra time because the more time you have before expiration, the lower the stock is expected to go.
  3. Choose a strike price. The strike price is the amount a stock must meet before a put option can be exercised. For example, if you buy a put option with a strike price of $30, you are able to sell the option at $30, although you aren’t under any obligation to. Remember that the goal of put options is to buy low and sell high.

Buying a Call Option

If you’re a stock buyer who wants to purchase the option to buy stocks, consider first buying a call option. To buy a call option, follow these steps:

  1. Find a stock you want to buy. This should be a stock that you expect to increase in value. The idea is that you want to have the option to buy that stock before it rises too high.
  2. Buy the call option. The call option is your right, without being under any obligation, to buy a security (in groups of 100 shares) once the stock price reaches a predetermined amount before a predetermined expiration date.
  3. Choose whether to exercise your call option or to sell your call. Once you have a call option, you may choose to sell the option if the stock isn’t moving, only losing the premium you paid for the option. Or, if you see that a stock is increasing in value, you may want to exercise your call option and buy the stock at the agreed-upon price. You don’t have to wait until the expiration date to make a move.

A security’s put/call ratio really does tell a story, guiding you in your next investment move. The ratio allows you to make a more educated decision when it comes to your investments and choose the right time to buy or sell securities so you can reach a maximum profit.

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

 

All eyes focused on the Fed last week, and rightfully so.

No one expected them to adjust rates.

But they failed to offer additional support for the markets, even verbally.

That left bulls running for the exits.

Tech stocks from Advanced Micro Devices (AMD) to Apple (AAPL) crumbled more than 20% from their highs. 

And that’s bear market territory, folks.

So, where does that leave us this week?

Three main themes will drive stocks this week.

  1. Jerome Powell delivers testimony to Congress on Thursday. Traders want to know what steps the Fed will or won’t take to juice the economy.
  2. Second, Treasury auctions matter a lot more these days. Ben Sturgill pointed out in his Daily Deposits how stocks now take their cue from bond auctions.
  3. Last, and certainly not least, the political tension sits in the air like the eye of a hurricane.

Here’s how analyzing Fed led me to a superb trade in FCX this last week in my High Octane Options.

 

A rock and infinity

 

Jerome Powell made it clear the Fed will tolerate excess inflation for a while.

Pushing aside economic academia that guided the Fed for the last century, he noted the relationship between unemployment and inflation no longer exists.

Therefore, he sees the Fed’s role and duty to drive down unemployment until inflation becomes an issue.

To the dismay of permabulls, this doesn’t mean an ever-expanding balance sheet.

The Fed saw no reason to continue asset purchases at the previous rate.

Hence the selloff in big tech benefited from the low-interest rate debt.

Yet, the dollar remains stubbornly cheap…and looking like it will get cheaper.

 

UUP Monthly Chart

 

Cheap dollars benefit multi-national companies, especially exporters.

And, as copper prices rose steadily, Freeport MacMoran (FCX) reaped big benefits.

 

FCX Daily Chart

 

The stock has more than quadrupled off the March lows.

Seeing this strong trend, I picked up some quick cash with long call options in the stock, locking in gains, and letting the rest ride higher.

As long as the Fed keeps pushing inflation, industrials and especially material stocks stand to benefit.

But, there is a potential wrinkle in the Fed’s plans…one that could lead to a larger pullback.

 

Growing debt problems

 

Despite political posturing, there is little historical evidence that either political party manages debt better.

In fact, the only time I remember our national debt shrinking was in the 1990s, spurred on by a decade of internet growth.

Ahh, the good old days…

 

 

I wonder what happened to those acid wash jeans…

 

Congress passed the largest stimulus in history to soften the blow of the pandemic.

Much of it has been financed by the loose Fed policy.

Yet, the growing debt continues to weigh on investors.

Without the Fed expanding its balance sheet, the remaining bonds must be scooped up by other investors.

However, the exorbitantly low-interest rates and outlook for more supply isn’t that enticing.

We already saw treasury yields slip this week and the subsequent selloff in tech.

As the supply of bonds grows to fund the deficit, the downward pressure on bond prices will drive up yields.

And that would certainly curtail equity market growth.

That’s why I’m watching both the Fed and the auctions closely this week to see whether these trends continue.

Both will set my outlook for the markets for the next 3-9 months.

But in between then, we have a little thing called an election.

 

In case it wasn’t dirty enough

 

With the passing of Justice Ruth Bader Ginsburg, a long-awaited vacancy appeared that President Trump itches to fill.

Objectively, the death of one of the more liberal justices and the likely replacement with a conservative one will shift the ideological balance of the high court.

Democrats already hit the airwaves to compare the situation to the Antonin Scalia vacancy, calling on Republicans to hold off on filling the seat.

As expected, Majority Leader Mitch McConnell and President Trump stated that they will move forward with a nomination, most likely Amy Coney Barrett of Indiana, U.S. Court of Appeals for the 7th Circuit who was a finalist behind Justice Brett Kavanaugh.

In reality, there is a marked difference between Judge Merrick Garland’s nomination and now.

Republicans control the Senate and the White House with enough time to confirm the nominee, even if they lose control of the chamber and the White House.

All of this will certainly play into the election rhetoric.

The question is how each side decides to play their cards.

Both Republicans and Democrats will look to leverage the events to increase their voter turnout.

So I wouldn’t be surprised to see the actual nomination drag out right until or even after the election.

Polls currently show Joe Biden closing in on 50% – a key number for a potential win.

As a reference, neither Hillary Clinton nor President Trump garnered numbers in the high 40s simply because many voters, estimated at anywhere from 10%-20%, hadn’t yet made up their minds.

This time around, there appears to be half that amount, hence the higher poll numbers for both candidates.

Markets will begin to respond based on who they perceive the likely victor as well as control of the senate.

At the moment, the House is expected to remain in Democratic control.

The Senate is the big question market.

And if you want to see some real polarization, watch what happens if we get a 50/50 split senate and need the VP to break the tie-breakers.

 

Translation into trades

 

Politics will dominate the main news networks this week but should have little impact on the markets.

I laid out my thoughts above as objectively as possible so you aren’t surprised by what happens and can look past it to what really matters.

This week, that’s the Fed and bonds.

I will keep a sharp eye on both including the treasury market ETF TLT.

In fact, my Bullseye Trade of the Week comes directly from these analyses.

Last week’s call in Dupont (DD) scored some nice wins for a few members.

 

*See disclaimer below

 

There’s still time to get Monday’s Bullseye Trade before the opening bell.

Click here to learn more about Bullseye Trades

 

Stocks I want to bet against this week…

AAPL, YETI, CMG, WY, FEYE, XLRE, XLP

Stocks I want to buy this week…

FCX, CAT, DE, PTON, DKNG, RH, PLUG, DD, FSLY, COF

 

This Week’s Calendar

 

Monday, September 21st

  • Nothing of note

Tuesday, September 22nd

    • 7:45 AM EST – ICSC Weekly Retail Sales
    • 10:00 AM EST – Existing Home Sales August
    • 10:00 AM EST – Richmond Fed Index September
    • 1:00 PM EST – U.S. Treasury $52B 2-Year Note Auction
    • 4:30 PM EST – API Weekly Inventory Data
  • Tesla Battery Day
  • Major earnings:  Autozone (AZO), KB Homes (KBH), Nike (NKE), StitchFix (SFIX), Steelcase (SCS).

Wednesday, September 23rd

  • 7:00 AM EST – MBA Mortgage Applications Data
  • 9:00 AM EST – Monthly Home Price Index July
  • 10:30 AM EST – Weekly DOE Inventory Data
  • 1:00 PM EST – U.S. Treasury $53B 5-Year Note Auction
  • Major earnings: General Mills (GIS), Cintas (CTAS).

Thursday, September 24th

  • 8:30 AM EST – Weekly Jobless & Continuing Claims
  • 10:00 AM EST – Jerome Powell Testimony
  • 10:00 AM EST – New Home Sales August
  • 10:30 AM EST – EIA Natural Gas Inventory Data
  • 11:00 AM EST – Kansas City Fed Manufacturing Index September
  • 1:00 PM EST – U.S. Treasury $50B 7-Year Note Auction
  • Major earnings: Aytu BioScience Inc (AYTU), Darden Restaurants Inc (DRI), Dynatronics Corp (DYNT), Jabil Inc (JBL), CarMax, Inc (KMX), Rite Aid (RAD), Costco Wholesale Corp (COST).

Friday, September 25th

  • 8:30 AM EST – Durable Goods August
  • 1:00 PM EST – Baker Hughes Rig Count
  • Major earnings: None of note

 

*RagingBull does NOT track or verify subscribers’ individual trading results and these individual experiences should NOT be understood as typical as or representative. Please see our Testimonials Disclaimer here: https://ragingbull.com/disclaimer

 

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

“I  just want to say one word to you…

Just one word.

Are you listening?

Plastics.”

Film buffs will recognize this phrase.

A mildly inebriated businessman tells Benjamin Braddock (Dustin Hoffman) that plastics will be the wave of the future in the 1967 classic The Graduate.

 

 

I thought long and hard about what the next wave of the future would be if Hollywood decided to remake this movie.

And I have that “one word” for you today.

 

The Word of the Day

 

Hollywood ran out of ideas years ago.

That’s why they’re rebooting, remaking, and reselling our old favorites to us.

What 1980s film hasn’t been redone already?

That’s why I was thinking about The Graduate recently.

It’s a brilliant movie. And this one little exchange of dialogue – “Plastics” – is at the heart of everything that great technology investors do around the world.

Trendspotting is at the core of making life-changing wealth.

So – I believe that if they remade that scene today… this businessman would look a CGI Dustin Hoffman in the face and say…

“Are you listening…”

ONE WORD…

Cybersecurity.”

The world has been moving online for years.

 

 

However, since COVID-19, that world has changed.

Meetings have moved online.

Documents are reviewed and signed online.

Banking and other financial transactions have moved online.

The world has gone online.

BUT… The criminals have followed right behind them.

And that’s going to create new problems… and new opportunities.

 

Digital Crime, Digital Opportunity

 

A decade ago, if someone wanted to rob you, they had to come to where you are to steal your money.

To conduct corporate espionage, you had to physically conduct surveillance on the company’s locations. You might even have to bring a little black bag and break into some office.

To rob a company, you had to show up at a location and threaten people to get the cash.

Having to commit the crime in the physical world gave local authorities a chance to capture the crooks before they got away.

That’s not the case today.

The people stealing and cashing in on your private data are now likely sitting on the other side of the planet.

It’s not some local tough guy ripping you off.

You might think it’s a computer geek inhaling Cheetos and Mountain Dew Code Red.

Regardless of that stereotype, remember that these are really smart people.

They know how to steal your cash and customer information in ways you’re not prepared to stop.

But this is elementary school math-level easy for them to do.

I’ve been doing a lot of reading about small businesses and cybersecurity over the last few months. And a new, disturbing business model for hackers has become all too common.

The cyberthieves hijack a company’s computer system and demand payment-usually in bitcoin- to restore access. Until the payment is made, you are out of business.

For example, Computer and Power Industries is a company based in California.

They make electronic components and subsystems focused primarily on the communications, defense, and medical sectors.

Well, a company IT administrator clicked on a link infected with ransomware, and the virus took over the company’s entire computer network.

The hackers demanded a ransom in Bitcoin – because the cryptocurrency is anonymous.

It cost them $500,000 to regain control of their business.

Remember, anonymity was supposed to be a benefit for people who owned Bitcoin…

Well that’s certainly true for cyberthieves.

And this is just one example.

How about Colorado Timberline? They were a printing company in Denver that suffered several cyber-attacks.

The last one was a ransomware attack, and it forced the company to close its doors forever. In a note to customers, the company said, “It is with great difficulty and a heavy heart that we must inform you that effective immediately Colorado Timberline has ceased all operations indefinitely.

We have recently been plagued by several IT events. Unfortunately, we were unable to overcome the most recent Ransomware attack, and as a result, this unfortunate and difficult decision was made.”

With the click of a mouse, a five-year company was gone, and 200 jobs were lost.

Do I have your attention yet?

That’s just two companies. I have a stack of stories and notes from phone calls on my desk.

I have HUNDREDS of examples now. Case studies. Personal stories. Real people whose small businesses have been lost.

And virtually no one is paying attention in the mainstream media.

This is only going to become a bigger problem.

 

The Cost of Digitalization

 

Cybersecurity company Sophos surveyed 5,000 IT professionals this year to learn how widespread ransomware attacks have become.

Sophis found that 51% of the companies represented by these professionals had been hit with ransomware.

In 26% of the attacks, the company ended up paying the ransom.

It’s not just businesses getting hit in 2020. We have seen attacks on government agencies, schools, and even hospitals this year.

Local police and even the FBI are powerless to do anything to stop the attacks or catch the bad guys.

Cybersecurity has gone from being an item of mild concern for businesses large and small to a vital component of being in business.

Cybercrime can put you out of business in an instant. All of your customer’s data can be stolen and sold to your competitors.

 

 

This is a cost that will go higher every year as thieves get more sophisticated.

Which is why I’m paying very close attention to the opportunity here.

Cybersecurity stocks have barely gotten started on their bull run. The companies that can play defense for small and mid-sized businesses are going to see their stock surge.

We could also see their valuations expand even higher, which is very good for share prices.

The trick is going to be picking the right companies.

I am spending a lot of time working on that question right now.

I’m reading the SEC filings of public cybersecurity companies.

I’m talking to people in the IT business to see who is getting this right and who will probably not be a significant cybersecurity player.

I just want to let you know that this is top of mind. We’ll get the right stock to take this incredible journey higher.

As soon as we have a conclusion, I’ll give my portfolio subscribers the heads up first.

Now, if you’re not onboard to receive those alerts, click here to find out how.

I believe there will be a lot of money to be made in these markets right now, there’s no reason why you should miss out.

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

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